Statement on ‘Innovation’ by SEC and CFTC Signals Predictions Markets Are Here to Stay

“Federal financial regulators are now on a mission to support predictions markets like Kalshi, not impede them, as made clear by a joint statement last week from the Securities Exchange Commission (SEC) and Commodity Futures Exchange Commission (CFTC). That further confirms the apparent about-face made by the CFTC since Donald Trump took office, and suggests we may only have seen the tip of the iceberg when it comes to gambling-like products being regulated as financial ones.

The two commissions will hold a joint roundtable on regulatory harmonization on September 29. The list of topics for that meeting includes “event contracts,” which is the technical term for bets like the ones Kalshi offers. Each such contract consists of a Yes share and a No share, with the holder of the correct share receiving $1 when the contract is resolved. Markets like Kalshi facilitate the trading of these contracts but don’t take “the other end” of a bet themselves, like a sportsbook would.

The contracts can be on virtually anything, including sports and world events. The resulting markets play out a bit like a poker game, as participants try to beat the competition at making inferences from imperfect information, while anticipating how others will react to a developing situation.

Under the Biden administration, the CFTC had attempted to prohibit trading on sports and domestic election results. However, it has since dropped all its investigations. The joint statement with the SEC makes it clear that predictions markets and other “innovators” can expect no further interference.

It is a new day at the SEC and the CFTC, and today we affirm the need to ensure regulation does not stand in the way of progress.”

Let the Gold Rush Begin

The subtext of that statement is that the world of events contracts is likely to become even more like the Wild West than it already is.

That analogy isn’t carelessly made. The actual “Wild West” era emerged out of the California Gold Rush, under similar circumstances. When a new opportunity presents itself, people rush to take advantage of it, while the federal lawmaking apparatus is slow-moving by design. It cannot possibly keep up with such situations.

The fall of the Professional and Amateur Sports Protection Act (PASPA) in 2018 kicked off an Online Gambling Rush of sorts. What we’re now seeing is the aftermath of that. While many states successfully legalized sports betting, they did so haphazardly. Demand is high across the country for online gambling under a unified model, free from idiosyncratic state-level prohibitions on what bets are and aren’t permitted.

In the 19th century, the Western U.S. faced a crisis based on a lack of property laws that could keep up with the influx of gold prospectors. The system of land claims that emerged out of that gave rise to the vigilante justice system of the Wild West, as land claimants were mostly left to sort things out on their own. Similarly, the SEC/CFTC statement promises “innovation exemptions” from existing regulations to companies looking to build commercially viable models in the short term, while the agencies sort out the rule-making problem over the longer term.

New companies are flooding in to take advantage of the possibilities. Self-directed investment platform Robinhood added predictions markets this year and is now in the S&P 500 for the first time. Polymarket, which was ejected from the U.S. in 2022 is now coming back, while PredictIt owner Aristotle has been given the go-ahead to launch a full-fledged trading platform.

What Do the SEC and CFTC Regulate?

It’s not entirely clear why the SEC needs to involve itself with predictions markets at all. To date, they’ve fallen entirely under the purview of the CFTC. However, former Kalshi lawyer Eliezer Mishory was appointed by the new “Department of Government Efficiency (DOGE)” to spearhead its efforts at that Commission.

Between themselves, the SEC and CFTC regulate all legal financial investment and speculation in the US. However, they cover different product classes.

Put simply, the SEC regulates more traditional securities like stocks and bonds, while the CFTC regulates derivatives like stock options and commodity futures.

For some innovative products like cryptocurrency, the need for inter-agency collaboration is more obvious. The regulated buying and selling of crypto would fall under SEC purview, but many speculators prefer to trade crypto futures, which would be the CFTC’s responsibility. Friday’s joint statement was preceded by a smaller announcement last Tuesday that they would be cooperating on a project to fast-track regulation for crypto trading.

Companies like DraftKings and FanDuel may begin to pursue predictions market and crypto plans more aggressively now that the responsible federal agencies have declared open season. Their respective CEOs have been cagey in the past, acknowledging the opportunity but saying they were still assessing the risks. Those risks now seem much lower after last week’s announcement.

What Other Innovations Are the SEC and CFTC Encouraging?

Event contracts were just one of the novel products mentioned in the announcement.

Other innovations the SEC and CFTC have said they want to encourage include:

• 24/7 trading: Speculators coming from unregulated cryptocurrency markets are used to being able to trade around the clock. The joint statement suggets the possibility of updating traditional markets — such as U.S. stock exchanges — to match, which would be a massive change for the finance world.
• Perpetual contracts: Traditional futures and similar contracts must be closed out before their expiration date. However, the world of cryptocurrency trading has introduced the idea of perpetual contracts, which don’t expire. The idea predates cryptocurrency, but wasn’t possible under existing regulations. Given that “perps” are by far the most popular form of derivative in cryptocurrency speculation, the commissions think it’s time to consider bringing them to regulated markets.
• Portfolio margining: The two commissions want to collaborate to allow entities with mutually hedging positions in different product categories to offset them when it comes to collateralization requirements. Typically, someone trading on margin has to put up a minimum amount of collateral to back their trade. However, if an SEC-regulated product happens to mitigate the risk of a CFTC-regulated one or vice versa, the commissions want to establish a procedure by which that can be taken into account and lower the necessary collateral accordingly.